DEPARTMENT OF THE TREASURY Internal
Revenue Service 26 CFR Parts 1 and 602

AGENCY:

Internal Revenue Service (IRS), Treasury.

ACTION:

Final regulations and removal of temporary regulations.

SUMMARY:

This document contains final regulations under section 882(c)
of the Internal Revenue Code (Code) concerning the determination of
the interest expense deduction of foreign corporations engaged in
a trade or business within the United States. These final regulations
conform the interest expense rules to recent U.S. Income Tax Treaty
agreements and adopt other changes to improve compliance.

DATES:

These final regulations are effective September 28, 2009.

FOR FURTHER INFORMATION CONTACT:

Anthony J. Marra, (202) 622-3870 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collection of information contained in these final regulations
has been reviewed and approved by the Office of Management and Budget
in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C.
3507(d)) under control number 1545-2030. Responses to this collection
of information are mandatory. The collection of information in these
final regulations is in §1.884-1(e)(3)(iv). This information
is required by the IRS to allow a taxpayer to reduce U.S. liabilities
to the extent necessary to prevent the recognition of a dividend equivalent
amount.

An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless the collection of
information displays a valid control number.

Books and records relating to a collection of information must
be retained as long as their contents may become material in the administration
of any internal revenue law. Generally, tax returns and tax return
information are confidential, as required by 26 U.S.C. 6103.

Background

On August 17, 2006, the Treasury Department and the IRS published
T.D. 9281 (71 FR 47443-01, 2006-2 C.B. 517) (the temporary regulations)
under section 882(c) of the Internal Revenue Code regarding the determination
of a foreign corporation’s interest expense allocable to income
effectively connected with the conduct of a trade or business within
the United States. On the same day, a notice of proposed rulemaking
(REG-120509-06, 71 FR 47459, 2006-2 C.B. 570) was published by cross-reference
to the temporary regulations in the Federal
Register. See §601.601(d)(2)(ii)(b).

Section 1.882-5 generally requires a foreign corporation to
use a three-step calculation to determine the amount of interest expense
that is allocable under section 882(c) to income effectively connected
(or treated as effectively connected) with the foreign corporation’s
conduct of a trade or business within the United States. The notice
of proposed rulemaking (the proposed regulations) provided for certain
changes in the three-step calculation. First, the proposed regulations
revised the election to use fair market value rather than adjusted
basis in valuing U.S. assets in Step 1. That revision required the
taxpayer to use fair market valuations for both Step 1 purposes and
the entire determination of the actual ratio in Step 2. The proposed
regulations also revised the Step 2 elective fixed ratio for foreign
banks, allowing a 95 percent fixed ratio to be used in lieu of the
actual ratio. In Step 3, the proposed regulations allowed a foreign
bank with excess U.S.-connected liabilities over U.S.-booked liabilities
under the adjusted U.S. booked liabilities (AUSBL) method to elect
to use the 30-day London Interbank Offering Rate (LIBOR) to calculate
interest on the excess U.S.-connected liabilities.

In addition to the changes in the three-step calculation, the
proposed regulations implemented guidance provided in Notice 2005-53,
2005-2 C.B. 263, regarding the interaction of §1.882-5 and U.S.
income tax treaties in recognition that recent treaties expressly
permit taxpayers to determine attribution of business profits to a
permanent establishment by analogy to the 1995 Organisation for Economic
Co-operation and Development Transfer Pricing Guidelines (Authorized
OECD Approach). For purposes of applying the branch profits tax,
the proposed regulations expanded the election under §1.884-1
to allow a taxpayer to reduce U.S. liabilities to the extent necessary
to prevent the recognition of a dividend equivalent amount, but not
below zero. Finally, the proposed regulations clarified the application
of the 1996 final regulations under §1.882-5 with respect to
certain direct interest allocations, the definition of U.S.-booked
liabilities, and the treatment of certain currency gain and loss for
purposes of §1.882-5. The preamble of T.D. 9281 includes background
information with respect to the proposed regulations and a further
explanation of these provisions. See §601.601(d)(2)(ii)(b).

The IRS received written comments in response to the proposed
regulations. No requests to speak at a public hearing were received
and no hearing was held. After consideration of the comments received,
the proposed regulations are adopted without substantive change by
this Treasury decision, and the corresponding temporary regulations
are removed. To relieve taxpayers of the burden of duplicative reporting,
these final regulations coordinate the various elections provided
in the three-step formula with the filing of taxpayer’s Schedule
I (Form 1120-F). Taxpayers filing protective tax returns under §1.882-4(a)(3)(vi)
may make §1.882-5 protective elections by attaching Schedule
I to a timely filed return (including extensions). Taxpayers must
separately attach to the Form 1120-F, any election to reduce U.S.
liabilities for branch profits tax purposes as permitted by §1.884-1(e)(3).
A taxpayer’s Schedule I must reflect the cumulative amount
of all U.S. liability reductions.

Many of the comments received raised issues specific to certain
financial transactions that require broader considerations than the
interaction of §1.882-5 and those financial transactions. The
Treasury Department and the IRS received a number of comments requesting
that the 1996 proposed hedging regulations (INTL-0054-95, 1996-1 C.B.
844) be finalized and expanded, in certain cases, to cover interbranch
activities (including currency gains and losses). Since those regulations
were proposed, the increase in interdesk and interbranch hedging (in
both dealer and nondealer operations) has given rise to special considerations
other than the familiar limitations associated with capital and ordinary
income distinctions. In this regard, the proposed 1998 global dealing
regulations, for example, require special considerations as to the
appropriate treatment of risk transfer agreements in similar circumstances.
In light of the need for a broader consideration of these issues,
the Treasury Department and the IRS are not adopting the suggestions
outlined in the comments received at this time. See §601.601(d)(2)(ii)(b).

Commentators also suggested that the regulations adopt special
rules that would govern the treatment of certain integrated financial
transactions such as effectively connected sale-repurchase agreements
and securities lending transactions. The commentators suggested the
adoption of a direct tracing rule that would, in effect, give zero
risk weighting to such assets, especially in defined dealer books
consisting of sale-repurchase transactions and securities loans involving
U.S. Treasuries and other government securities. The suggested rule
would scale back the amount of capital that is imputed to such portfolios
under either the actual ratio or the fixed ratio to reflect the economic
reality that such assets are entirely debt-financed. Commentators
also suggested that “netting” rules apply for offsetting
notional principal contracts within discrete portfolios. Finally,
commentators suggested revisions to the definition of U.S.-booked
liabilities that would exclude certain conduit interbranch lending
arrangements. The Treasury Department and the IRS are not adopting
these suggestions at this time but continue to consider the issues
raised in this context and intend to coordinate these issues, where
appropriate, with similar issues in analogous contexts, such as global
dealing operations and section 864(e). See Notice 2001-59, 2001-2
C.B. 315. See §601.601(d)(2)(ii)(b).

Section 861(a)(1)(C), as amended by the American Jobs Creation
Act of 2004 provides a special source rule for interest on obligations
of certain foreign partnerships and may require coordinating changes
to the branch-level interest tax rules under §1.884-4. Specifically,
a foreign corporate partner is not treated as paying branch interest
under §1.884-4(b)(1)(i)(A) and therefore may be liable for tax
on excess interest even if that foreign partner has U.S. book interest
paid with respect to its distributive share of U.S. booked liabilities
under §1.882-5. Accordingly, the Treasury Department and the
IRS are currently considering how best to coordinate the U.S. booked
liability rules with the determination of partnership branch interest
so that foreign corporate partners of partnerships described in section
861(a)(1)(C) are provided similar treatment under §1.884-4 with
respect to their distributive shares of interest expense as foreign
corporations directly engaged in a trade or business within the United
States.

Special Analyses

It has been determined that this Treasury decision is not a
significant regulatory action as defined in Executive Order 12866.
Therefore, a regulatory assessment is not required. It also has
been determined that section 553(b) of the Administrative Procedure
Act (5 U.S.C. chapter 5) does not apply to these regulations. It
is hereby certified that the collection of information contained in
these regulations will not have a significant economic impact on a
substantial number of small entities. Accordingly, a regulatory flexibility
analysis under the Regulatory Flexibility Act (5 U.S.C. chapter 6)
is not required. The collection of information requirement in these
regulations generally only affects large foreign banks. Thus, the
number of affected small entities will not be substantial and any
economic impacts on those entities in complying with the collection
of information would be minimal. Pursuant to section 7805(f) of the
Code, these regulations have been submitted to the Chief Counsel for
Advocacy of the Small Business Administration for comment on its impact
on small business.

Adoption of Amendments to the Regulations

Accordingly, 26 CFR parts 1 and 602 are amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to
read in part as follows:

§1.882-5 Determination of interest deduction.

(a)(1) Overview—(i) In
general. The amount of interest expense of a foreign corporation
that is allocable under section 882(c) to income which is (or is treated
as) effectively connected with the conduct of a trade or business
within the United States (ECI) is the sum of the interest allocable
by the foreign corporation under the three-step process set forth
in paragraphs (b), (c), and (d) of this section and the specially
allocated interest expense determined under paragraph (a)(1)(ii) of
this section. The provisions of this section provide the exclusive
rules for allocating interest expense to the ECI of a foreign corporation
under section 882(c). Under the three-step process, the total value
of the U.S. assets of a foreign corporation is first determined under
paragraph (b) of this section (Step 1). Next, the amount of U.S.-connected
liabilities is determined under paragraph (c) of this section (Step
2). Finally, the amount of interest paid or accrued on U.S.-booked
liabilities, as determined under paragraph (d)(2) of this section,
is adjusted for interest expense attributable to the difference between
U.S.-connected liabilities and U.S.-booked liabilities (Step 3).
Alternatively, a foreign corporation may elect to determine its interest
rate on U.S.-connected liabilities by reference to its U.S. assets,
using the separate currency pools method described in paragraph (e)
of this section.

(ii) Direct allocations—(A) In general. A foreign corporation that has a U.S. asset
and indebtedness that meet the requirements of §1.861-10T (b)
or (c), as limited by §1.861-10T(d)(1), shall directly allocate
interest expense from such indebtedness to income from such asset
in the manner and to the extent provided in §1.861-10T. For
purposes of paragraph (b)(1) or (c)(2) of this section, a foreign
corporation that allocates its interest expense under the direct allocation
rule of this paragraph (a)(1)(ii)(A) shall reduce the basis of the
asset that meets the requirements of §1.861-10T (b) or (c) by
the principal amount of the indebtedness that meets the requirements
of §1.861-10T (b) or (c). The foreign corporation shall also
disregard any indebtedness that meets the requirements of §1.861-10T
(b) or (c) in determining the amount of the foreign corporation’s
liabilities under paragraphs (c)(2) and (d)(2) of this section and
shall not take into account any interest expense paid or accrued with
respect to such a liability for purposes of paragraph (d) or (e) of
this section.

(B) Partnership interest. A foreign corporation
that is a partner in a partnership that has a U.S. asset and indebtedness
that meet the requirements of §1.861-10T (b) or (c), as limited
by §1.861-10T(d)(1), shall directly allocate its distributive
share of interest expense from that indebtedness to its distributive
share of income from that asset in the manner and to the extent provided
in §1.861-10T. A foreign corporation that allocates its distributive
share of interest expense under the direct allocation rule of this
paragraph (a)(1)(ii)(B) shall disregard any partnership indebtedness
that meets the requirements of §1.861-10T (b) or (c) in determining
the amount of its distributive share of partnership liabilities for
purposes of paragraphs (b)(1), (c)(2)(vi), and (d)(2)(vii) or (e)(1)(ii)
of this section, and shall not take into account any partnership interest
expense paid or accrued with respect to such a liability for purposes
of paragraph (d) or (e) of this section. For purposes of paragraph
(b)(1) of this section, a foreign corporation that directly allocates
its distributive share of interest expense under this paragraph (a)(1)(ii)(B)
shall—

(1) Reduce the partnership’s basis
in such asset by the amount of such indebtedness in allocating its
basis in the partnership under §1.884-1(d)(3)(ii); or

(2) Reduce the partnership’s income
from such asset by the partnership’s interest expense from such
indebtedness under §1.884-1(d)(3)(iii).

(2) Coordination with tax treaties. Except
as expressly provided by or pursuant to a U.S. income tax treaty or
accompanying documents (such as an exchange of notes), the provisions
of this section provide the exclusive rules for determining the interest
expense attributable to the business profits of a permanent establishment
under a U.S. income tax treaty.

* * * * *

(7) Elections under §1.882-5—(i) In general. A corporation must make each election provided
in this section on the corporation’s original timely filed Federal
income tax return for the first taxable year it is subject to the
rules of this section. An amended return does not qualify for this
purpose, nor shall the provisions of §301.9100-1 of this chapter
and any guidance promulgated thereunder apply. Except as provided
elsewhere in this section, each election under this section, whether
an election for the first taxable year or a subsequent change of election,
shall be made by indicating the method used on Schedule I (Form 1120-F)
attached to the corporation’s timely filed return. An elected
method (other than the fair market value method under paragraph (b)(2)(ii)
of this section, or the annual 30-day London Interbank Offered Rate
(LIBOR) election in paragraph (d)(5)(ii) of this section) must be
used for a minimum period of five years before the taxpayer may elect
a different method. To change an election before the end of the requisite
five-year period, a taxpayer must obtain the consent of the Commissioner
or his delegate. The Commissioner or his delegate will generally
consent to a taxpayer’s request to change its election only
in rare and unusual circumstances. After the five-year minimum period,
an elected method may be changed for any subsequent year on the foreign
corporation’s original timely filed tax return for the first
year to which the changed election applies.

(ii) Failure to make the proper election. If a taxpayer, for any reason, fails to make an election provided
in this section in a timely fashion, the Director of Field Operations
may make any or all of the elections provided in this section on behalf
of the taxpayer, and such elections shall be binding as if made by
the taxpayer.

(iii) Step 2 special election for banks. For the first taxable year for which an original income tax return
is due (including extensions) after August 17, 2006, in which a taxpayer
that is a bank as described in paragraph (c)(4) of this section is
subject to the requirements of this section, a taxpayer may make a
new election to use the fixed ratio on an original timely filed return.
A new fixed ratio election may be made in any subsequent year subject
to the timely filing and five-year minimum period requirements of
paragraph (a)(7)(i) of this section. A new fixed ratio election under
this paragraph (a)(7)(iii) is subject to the adjusted basis or fair
market value conforming election requirements of paragraph (b)(2)(ii)(A)(2) of this section and may not be made if a taxpayer elects
or maintains a fair market value election for purposes of paragraph
(b) of this section. Taxpayers that already use the fixed ratio method
under an existing election may continue to use the new fixed ratio
at the higher percentage without having to make a new five-year election
in the first year that the higher percentage is effective.

* * * * *

(b) * * *

(2) * * *

(ii) * * *

(A) In general—(1) Fair market value conformity requirement.
A taxpayer may elect to value all of its U.S. assets on the basis
of fair market value, subject to the requirements of §1.861-9T(g)(1)(iii),
and provided the taxpayer is eligible and uses the actual ratio method
under paragraph (c)(2) of this section and the methodology prescribed
in §1.861-9T(h). Once elected, the fair market value must be
used by the taxpayer for both Step 1 and Step 2 described in paragraphs
(b) and (c) of this section, and must be used in all subsequent taxable
years unless the Commissioner or his delegate consents to a change.

(2) Conforming election requirement. Taxpayers that as of the effective date of this paragraph (b)(2)(ii)(A)(2) have elected and currently use both the fair market
value method for purposes of paragraph (b) of this section and a fixed
ratio for purposes of paragraph (c)(4) of this section must conform
either the adjusted basis or fair market value methods in Step 1 and
Step 2 of the allocation formula by making an adjusted basis election
for paragraph (b) of this section purposes while continuing the fixed
ratio for Step 2, or by making an actual ratio election under paragraph
(c)(2) of this section while remaining on the fair market value method
under paragraph (b) of this section. Taxpayers who elect to conform
Step 1 and Step 2 of the formula to the adjusted basis method must
remain on both methods for the minimum five-year period in accordance
with the provisions of paragraph (a)(7) of this section. Taxpayers
that elect to conform Step 1 and Step 2 of the formula to the fair
market value method must remain on the actual ratio method until the
consent of the Commissioner or his delegate is obtained to switch
to the adjusted basis method. If consent to use the adjusted basis
method in Step 1 is granted in a later year, the taxpayer must remain
on the actual ratio method for the minimum five-year period unless
consent to use the fixed ratio is independently obtained under the
requirements of paragraph (a)(7) of this section. For the first taxable
year for which an original income tax return is due (including extensions)
after August 17, 2006, taxpayers that are required to make a conforming
election under this paragraph (b)(2)(ii)(A)(2), may do so on an original timely filed return. If a conforming
election is not made within the timeframe provided in this paragraph,
the Director of Field Operations or his delegate may make the conforming
elections in accordance with the provisions of paragraph (a)(7)(ii)
of this section.

* * * * *

(3) Computation of total value of U.S. assets—(i) General rule. The total value of
U.S. assets for the taxable year is the average of the sums of the
values (determined under paragraph (b)(2) of this section) of U.S.
assets. For each U.S. asset, value shall be computed at the most
frequent regular intervals for which data are reasonably available.
In no event shall the value of any U.S. asset be computed less frequently
than monthly (beginning of taxable year and monthly thereafter) by
a large bank (as defined in section 585(c)(2)) or a dealer in securities
(within the meaning of section 475) and semi-annually (beginning,
middle and end of taxable year) by any other taxpayer.

(ii) Adjustment to basis of financial instruments. For purposes of determining the total average value of U.S. assets
in this paragraph (b)(3), the value of a security or contract that
is marked to market pursuant to section 475 or section 1256 shall
be determined as if each determination date is the most frequent regular
interval for which data are reasonably available that reflects the
taxpayer’s consistent business practices for reflecting mark-to-market
valuations on its books and records.

* * * * *

(c) * * *

(2) * * *

(iv) Determination of value of worldwide assets. The value of an asset must be determined consistently from year
to year and must be substantially in accordance with U.S. tax principles.
To be substantially in accordance with U.S. tax principles, the principles
used to determine the value of an asset must not differ from U.S.
tax principles to a degree that will materially affect the value of
the taxpayer’s worldwide assets or the taxpayer’s actual
ratio. The value of an asset is the adjusted basis of that asset
for determining the gain or loss from the sale or other disposition
of that asset, adjusted in the same manner as the basis of U.S. assets
are adjusted under paragraphs (b)(2) (ii) through (iv) of this section.
The rules of paragraph (b)(3) of this section apply in determining
the total value of applicable worldwide assets for the taxable year,
except that the minimum number of determination dates are those stated
in paragraph (c)(2)(i) of this section.

* * * * *

(4) Elective fixed ratio method of determining U.S.
liabilities. A taxpayer that is a bank as defined in section
585(a)(2)(B) (without regard to the second sentence thereof or whether
any such activities are effectively connected with a trade or business
within the United States) may elect to use a fixed ratio of 95 percent
in lieu of the actual ratio. A taxpayer that is neither a bank nor
an insurance company may elect to use a fixed ratio of 50 percent
in lieu of the actual ratio.

* * * * *

(d) * * *

(2) * * *

(ii) * * *

(B)(2) The foreign corporation enters
the liability on a set of books reasonably contemporaneously with
the time at which the liability is incurred and the liability relates
to an activity that produces ECI.

(3) The foreign corporation maintains a
set of books and records relating to an activity that produces ECI
and the Director of Field Operations determines that there is a direct
connection or relationship between the liability and that activity.
Whether there is a direct connection between the liability and an
activity that produces ECI depends on the facts and circumstances
of each case.

* * * * *

(iii) * * *

(A) In general. A liability, whether interest
bearing or non-interest bearing, is properly reflected on the books
of the U.S. trade or business of a foreign corporation that is a bank
as described in section 585(a)(2)(B) (without regard to the second
sentence thereof) if—

(1) The bank enters the liability on a
set of books before the close of the day on which the liability is
incurred, and the liability relates to an activity that produces ECI;
and

(2) There is a direct connection or relationship
between the liability and that activity. Whether there is a direct
connection between the liability and an activity that produces ECI
depends on the facts and circumstances of each case. For example,
a liability that is used to fund an interbranch or other asset that
produces non-ECI may have a direct connection to an ECI producing
activity and may constitute a U.S.-booked liability if both the interbranch
or non-ECI activity is the same type of activity in which ECI assets
are also reflected on the set of books (for example, lending or money
market interbank placements), and such ECI activities are not de minimis. Such U.S. booked liabilities may still be
subject to paragraph (d)(2)(v) of this section.

* * * * *

(5) * * *

(ii) Interest rate on excess U.S.-connected liabilities—(A) General rule. The applicable interest
rate on excess U.S.-connected liabilities is determined by dividing
the total interest expense paid or accrued for the taxable year on
U.S.-dollar liabilities that are not U.S.-booked liabilities (as defined
in paragraph (d)(2) of this section) and that are shown on the books
of the offices or branches of the foreign corporation outside the
United States by the average U.S.-dollar denominated liabilities (whether
interest-bearing or not) that are not U.S.-booked liabilities and
that are shown on the books of the offices or branches of the foreign
corporation outside the United States for the taxable year.

(B) Annual published rate election. For
each taxable year beginning with the first year end for which the
original tax return due date (including extensions) is after August
17, 2006, in which a taxpayer is a bank within the meaning of section
585(a)(2)(B) (without regard to the second sentence thereof or whether
any such activities are effectively connected with a trade or business
within the United States), such taxpayer may elect to compute its
excess interest by reference to a published average 30-day London
Interbank Offering Rate (LIBOR) for the year. The election may be
made for any eligible year by indicating the rate used on Schedule
I (Form 1120-F) attached to the timely filed return. Once selected,
the rate may not be changed by the taxpayer. If a taxpayer that is
eligible to make the 30-day LIBOR election either does not file a
timely return or files a calculation that allocates interest expense
under the scaling ratio in paragraph (d)(4) of this section and it
is determined by the Director of Field Operations that the taxpayer’s
U.S.-connected liabilities exceed its U.S.-booked liabilities, then
the Director of Field Operations, and not the taxpayer, may choose
whether to determine the taxpayer’s excess interest rate under
paragraph (d)(5)(ii)(A) or (B) of this section and may select the
published 30-day LIBOR rate.

(6) * * *

Example 5. U.S. booked liabilities
— direct relationship. (i) Facts. Bank A, a resident of Country X maintains a banking office in the
U.S. that records transactions on three sets of books for State A,
an International Banking Facility (IBF) for its bank regulatory approved
international transactions, and a shell branch licensed operation
in Country C. Bank A records substantial ECI assets from its bank
lending and placement activities and a mix of interbranch and non-ECI
producing assets from the same or similar activities on the books
of State A branch and on its IBF. Bank A’s Country C branch
borrows substantially from third parties, as well as from its home
office, and lends all of its funding to its State A branch and IBF
to fund the mix of ECI, interbranch and non-ECI activities on those
two books. The consolidated books of State A branch and IBF indicate
that a substantial amount of the total book assets constitute U.S.
assets under paragraph (b) of this section. Some of the third-party
borrowings on the books of the State A branch are used to lend directly
to Bank A’s home office in Country X. These borrowings reflect
the average borrowing rate of the State A branch, IBF and Country
C branches as a whole. All third-party borrowings reflected on the
books of State A branch, the IBF and Country C branch were recorded
on such books before the close of business on the day the liabilities
were acquired by Bank A.

(ii) U.S. booked liabilities. The facts
demonstrate that the separate State A branch, IBF and Country C branch
books taken together, constitute a set of books within the meaning
of paragraph (d)(2)(iii)(A)(1) of this section.
Such set of books as a whole has a direct relationship to an ECI
activity under paragraph (d)(2)(iii)(A)(2) of
this section even though the Country C branch books standing alone
would not. The third-party liabilities recorded on the books of Country
C constitute U.S. booked liabilities because they were timely recorded
and the overall set of books on which they were reflected has a direct
relationship to a bank lending and interbank placement ECI producing
activity. The third-party liabilities that were recorded on the books
of State A branch that were used to lend funds to Bank A’s home
office also constitute U.S. booked liabilities because the interbranch
activity the funds were used for is a lending activity of a type that
also gives rise to a substantial amount of ECI that is properly reflected
on the same set of books as the interbranch loans. Accordingly, the
liabilities are not traced to their specific interbranch use but to
the overall activity of bank lending and interbank placements which
gives rise to substantial ECI. The facts show that the liabilities
were not acquired to increase artificially the interest expense of
Bank A’s U.S. booked liabilities as a whole under paragraph
(d)(2)(v) of this section. The third-party liabilities also constitute
U.S. booked liabilities for purposes of determining Bank A’s
branch interest under §1.884-4(b)(1)(i)(A) regardless of whether
Bank A uses the Adjusted U.S. booked liability method, or the Separate
Currency Pool method to allocate its interest expense under paragraph
5(e) of this section.

* * * * *

(f)(1) Effective/applicability date—(1) General rule. This section is applicable for taxable
years ending on or after August 15, 2009. A taxpayer, however, may
choose to apply §1.882-5T, rather than applying the final regulations,
for any taxable year beginning on or after August 16, 2008 but before
August 15, 2009.

§1.882-5T [Removed]

§1.884-1 Branch profits tax.

* * * * *

(e) * * *

(3) * * *

(ii) Limitation. For any taxable year,
a foreign corporation may elect to reduce the amount of its liabilities
determined under paragraph (e)(1) of this section by an amount that
does not exceed the lesser of the amount of U.S. liabilities as of
the determination date, or the amount of U.S. liability reduction
needed to reduce a dividend equivalent amount as of the determination
date to zero.

* * * * *

(iv) Method of election. A foreign corporation
that elects the benefits of this paragraph (e)(3) for a taxable year
shall attach a statement to its return for the taxable year that it
has elected to reduce its liabilities for the taxable year under this
paragraph (e)(3) and that it has reduced the amount of its U.S.-connected
liabilities as provided in paragraph (e)(3)(iii) of this section and
shall indicate the amount of such reductions on such attachment.
The cumulative amount of all U.S. liability reductions is shown on
Schedule I (Form 1120-F) in addition to the separate elections attached
to the timely filed return. An election under this paragraph (e)(3)
must be made before the due date (including extensions) for the foreign
corporation’s income tax return for the taxable year.

* * * * *

(5) * * *

Example 2. Election made to
reduce liabilities. (i) As of the close of 2007, foreign
corporation A, a real estate company, owns U.S. assets with an E&P
basis of $1000. A has $800 of liabilities under paragraph (e)(1)
of this section. A has accumulated ECEP of $500 and in 2008, A has
$60 of ECEP that it intends to retain for future expansion of its
U.S. trade or business. A elects under paragraph (e)(3) of this section
to reduce its liabilities by $60 from $800 to $740. As a result of
the election, assuming A’s U.S. assets and U.S. liabilities
would otherwise have remained constant, A’s U.S. net equity
as of the close of 1994 will increase by the amount of the decrease
in liabilities ($60) from $200 to $260 and its ECEP will be reduced
to zero. Under paragraph (e)(3)(iii) of this section, A’s interest
expense for the taxable year is reduced by the amount of interest
attributable to $60 of liabilities and A’s excess interest is
reduced by the same amount. A’s taxable income and ECEP are
increased by the amount of the reduction in interest expense attributable
to the liabilities, and A may make an election under paragraph (e)(3)
of this section to further reduce its liabilities, thus increasing
its U.S. net equity and reducing the amount of additional ECEP created
for the election.

(ii) In 2009, assuming A again has $60 of ECEP, A may again
make the election under paragraph (e)(3) to reduce its liabilities.
However, assuming A’s U.S. assets and liabilities under paragraph
(e)(1) of this section remain constant, A will need to make an election
to reduce its liabilities by $120 to reduce to zero its ECEP in 2009
and to continue to retain for expansion (without the payment of the
branch profits tax) the $60 of ECEP earned in 2008. Without an election
to reduce liabilities, A’s dividend equivalent amount for 2009
would be $120 ($60 of ECEP plus the $60 reduction in U.S. net equity
from $260 to $200). If A makes the election to reduce liabilities
by $120 (from $800 to $680), A’s U.S. net equity will increase
by $60 (from $260 at the end of the previous year to $320), the amount
necessary to reduce its ECEP to $0. However, the reduction of liabilities
will itself create additional ECEP subject to section 884 because
of the reduction in interest expense attributable to the $120 of liabilities.
A can make the election to reduce liabilities by $120 without exceeding
the limitation on the election provided in paragraph (e)(3)(ii) of
this section because the $120 reduction does not exceed the amount
needed to treat the 2009 and 2008 ECEP as reinvested in the net equity
of the trade or business within the United States.

(iii) If A terminates its U.S. trade or business in 2009 in
accordance with the rules in §1.884-2T(a), A would not be subject
to the branch profits tax on the $60 of ECEP earned in that year.
Under paragraph (e)(3)(v) of this section, however, it would be subject
to the branch profits tax on the portion of the $60 of ECEP that it
earned in 2008 that became accumulated ECEP because of an election
to reduce liabilities.

* * * * *

§1.884-1T [Removed]

Par. 6. Section 1.884-1T is removed.

Par. 7. The authority citation for part 602 continues to read
as follows:

Authority: 26 U.S.C. 7805.

Par. 8. In §602.101, paragraph (b) is amended by removing
the entry for “§1.882-5T” from the table.

Note

(Filed by the Office of the Federal Register on September 25,
2009, 8:45 a.m., and published in the issue of the Federal Register
for September 28, 2009, 74 F.R. 49315)

Drafting Information

The principal author of these regulations is Anthony J. Marra
of the Office of Associate Chief Counsel (International). However,
other persons from the Office of Associate Chief Counsel (International)
and the Treasury Department have participated in their development.